AS the stock market looks likely to end the first month of this year in negative territory, investment analysts at Afrinvest West Africa have posited that 2017 may end up another difficult year for equities if certain drivers of the negative 2016 performance are not addressed urgently.

The analysts observed that market performance in 2016 indicated that although a combination of poor corporate releases as well as weak macroeconomic fundamentals contributed to the negative return for the year, market volatility remained largely consistent with instability in the currency market.

More specifically, according to them, while bearish sentiments persisted for most of 2016, equities rallied between May and July 2016 due to reforms in the Oil & Gas sector and adoption of the floating exchange rate regime. They also observed that the periods of widening exchange rate spread (between official and parallel market rates) and imposition of currency control measures correlated with the lowest points of the index.

These are the fundamental factors which they believe would determine the direction of the market in 2017, and going by some interim overviews on fiscal and monetary policy stance of the government and the regulatory authorities for 2017, there is less to cheer if truly these fundamentals would prevail.

Less optimistic position

Indicating this less optimistic position analysts at Afrinvest, in their 2017 prognosis released last week titled, ‘Nigerian Economic and Financial Outlook 2017’, stated: “It is apparent that key market drivers such as exchange rate, oil prices, oil production volumes and government revenue are still under siege while policy risk remains the biggest factor to watch. Thus, our fundamental view of market performance in 2017 is bearish as uncertainties remain so long as impediments to economic expansion stay unaddressed.”

The analysts listing policy uncertainty as the biggest factor to watch being at the epicentre of Nigeria’s recent economic difficulty in addition to the fact that the major factor responsible for the unresolved crisis in the currency market is a confidence deficit.

Against this background they stated: “Notwithstanding blunted monetary policy tools, we do not see the Apex Bank deviating from its history of policy volatility in 2017.”

There is also concern over the fiscal policy responses to the economic challenges. Afrinvest stated: “The capacity of the fiscal policy managers to implement policies to counter the raging economic recession remains a concern in the absence of a major policy response by the Ministry of Finance since the cabinet was constituted late 2015. Thus, the direction of policy framework is still blurry.

“The short to medium term implication of the above is therefore a protracted episode of stagflation justifying a bearish outlook for equities”, they added.

The other determinant of the fate of equity investments in 2017 is what the analysts call the “Troika”: Oil Proceeds, External Reserves and Exchange Rate

The historical trend of the Nigerian equities market indicates that performance has been tightly correlated to crude oil prices, accretion to gross external reserves and exchange rate stability. This is because capital flows into Nigeria are fundamentally driven by exchange rate stability and accretion to reserves, which is largely a function of oil proceeds.

Afrinvest analysts are of the view that the exchange rate crisis which has lingered for more than 24 months is expected to persist in 2017 given a benign outlook on proceeds from oil as well as poor policy responses.

Economic road map

They stated: “Despite a last minute agreement by OPEC and some non-OPEC members to cut output, short to medium term outlook suggests oil prices are likely to stay at sub-US$60.00/b while militancy in the Niger Delta region will likely keep domestic production depressed. This combined with the absence of a clear cut economic road map by the federal government to recalibrate the economy away from recession implies a blurry outlook for equities.”

Apparently this perspective is on the backdrop of lack-lustre responses of foreign investors to all efforts by Nigeria to bring them back. The foreign investors are the dominant drivers of bullish sentiment in the Nigerian equity market.

Consequently, Afrinvest stated: “Our interactions with several foreign investors with interests in Nigeria suggests that a decision to stake any position in the Nigerian market will be a function of currency liquidity and a greater certainty on their ability to repatriate capital anytime they divest. As a result, we do not see significant foreign capital flowing into Nigerian equities in the short to medium term as the discrepancy between the parallel and interbank market rates continue to deter interest in Nigeria.

“Additionally, the likelihood of a further adjustment to the current interbank market rate which remain controlled despite recent reforms by the CBN, will keep investment in Nigeria soft.”

Added to this is the impact on corporate results as the analysts noted: “Foreign exchange bottlenecks are expected to continue to pressure operating metrics for corporates, given the negative impact on input cost, capital expenditure and financing. On the other hand, pressure on disposable income implies a soft outlook for revenue. Therefore, improvement in operating metrics will take a medium to long term to materialize. As such, we expect that appetite for equities will stay soft until the market has bottomed out.”

Positive flash in the horizon

Amidst the bleak scenario a flash of positivity in the bottoming out of the long standing bear run is seen around the next bend.

According to Afrinvest analysts, “notwithstanding the foregoing, our technical analysis indicates that a continuous downtrend in the market will trigger a rebound even in the absence of fundamental drivers as soon as market actors perceive prices to have reached its long term support level or bottomed out.

“As such, we are of the view that despite bearish indications from a fundamental point of view, there is a technical basis for an uptick in the index level immediately market valuation becomes ridiculously cheap (unless there is an unexpected policy misdirection from the CBN or the fiscal authorities).”

“To give credence to our position above, we analyze the 10-Year trend of the All Share Index (ASI) to determine the long-term support level. As shown in chart 27, the long term support level for the ASI is established at 20,000points. In the last 10 years, this support line has not been breached even during the global financial crisis of 2008 and the Eurozone market rout of 2011 both of which had the most devastating impact on financial markets around the world.

“Accordingly, we expect that despite a bearish outlook for equities, the index may not breach the 20,000 points support line in 2017 notwithstanding market sentiments.”

A further implication of the above, according to the analysts, is that short term speculative opportunities will persist in equities regardless of the broader sentiments in the economy as active traders can swiftly long the market once the index bottoms out or nears the 20,000 points support level and take profit when return targets are achieved.

They also see opportunities for speculative positioning ahead of foreseeable policy pronouncements by the Apex Bank and the fiscal authorities during the year as events in 2015 and 2016 have clearly shown.

Scenario Analysis in 2017

In view of the observed weaknesses in the system, Afrinvest says its base case scenario in 2016 predicted a 5.9% year-on-year (Y-o-Y) decline for the index if foreign exchange rate was adjusted to N265.00/ US$1.00, oil prices stabilizes above US$30.00/barrel, a 100 bases point hike in MPR to 12.0%, an appreciable performance of the 2016 budget and an improved global sentiment for equities.

Market performance

They stated: “In 2017, we envisage market performance to be broadly predicated on three critical economic outcomes. These include: The implementation of an economic recovery plan to restore economic growth; Resolution of the on-going crisis in the Niger Delta region and the impact on oil production volumes as well as revenue; Apex Bank’s resolve to fix the currency market crisis and close the huge gap between official and unofficial market rates once and for all.

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